What's in the Cards?

First National Bank of Scotia President John Buhrmaster has a message for community bankers thinking about issuing credit cards: Don't wait.

The $340 million-asset First National has been offering credit cards for about two years, and lately it has been flooded with applications from consumers and business owners that already have cards elsewhere. Buhrmaster says most applicants are existing First National customers fleeing large issuers, which have been slashing credit limits and hiking interest rates in response to the recession and changes in credit card marketing and disclosure rules.

"I personally believe that there has never been a better time for a community bank to get into the credit card business," Buhrmaster says. "Community banks have never had a better public perception than they do right now."

Others, however, aren't so sure that now is such a great time for small banks to start marketing credit cards. Though chargeoffs are expected to be lower this year than last, weak economic conditions and persistently high unemployment rates make card lending a risky business nowadays, analysts say. Moreover, the Credit Card Accountability and Disclosure Act passed last year has added new expenses for all card issuers—which many small banks couldn't afford.

Robert Hammer, chairman and chief executive of the card advisory firm R.K. Hammer in Thousand Oaks, Calif., says he would advise small banks to wait until the economy improves.

Dan Blanton, the CEO of the $1.5 billion-asset Georgia Bank and Trust Co. in Augusta, is one banker weighing the pros and cons. So far, he is holding off, because of the uncertain regulatory climate.

Still, Blanton agrees with Buhrmaster that community banks are well positioned to steal card business from larger banks. He also says that many small banks could use the interest income.

"Right now I need to be lending money and I don't have good loan demand in my market," he says.

The key to succeeding in the card business is in viewing the credit card as part of a larger financial relationship, experts say.

"The credit card customer tends to be a longer-term customer with the bank, someone who has maybe a bit more assets than somebody walking in the door. So it is a key relationship," says Linda Echard, the president and CEO of the Independent Community Bankers Association's Bancard program, which works with about 700 community banks that issue credit cards, including First National.

Buhrmaster says that while the cards themselves aren't big money-makers—they generate about as much profit as life insurance, wealth management or other ancillary offerings—they can go a long way toward deepening relationships. On average the customers with a business card at First National use two more products than business customers without a bank-issued credit card.

"We're getting real, real, real solid businesses—businesses that banks would stand in line to take," he says.

Few community banks actually own and manage their own credit card portfolios. Most either offer credit cards as agents of larger banks or the ICBA's card unit, or use third parties to manage portfolios for them.

Jim Walsh, president and CEO of the card consulting firm Brookwood Capital in Peterborough, N.H., suggests that banks bent on immediately getting into credit cards consider becoming an agent of another issuer.

This arrangement produces less income than owning a portfolio outright, but it can start generating income right away, without risk or ramp-up costs, Walsh says. Plus, it boosts the bank's brand, by putting a mini-billboard in each customer's wallet.

"They get that little billboard every time their customer uses it. And their customer doesn't know that somebody else owns it, so they get all of the benefits."

But Hammer says owning the portfolio but letting a third party run it gives banks more control over underwriting—and can be more lucrative. "You might make $20 or $30 per account as an agent, when you might make $40 or $50 per account in a servicing arrangement," Hammer says.

It also mitigates the bank's risk and operating expenses by offloading onerous tasks related to compliance and fraud. "I only have to worry about two things: underwriting and collections," says First National's Buhrmaster.

It's in those two areas—underwriting and collections—where community banks can excel. Because they know their customers and communities, they can underwrite and assess risk better than large card issuers, says Jerry Craft, the CEO at Corserv, an Atlanta servicer. This familiarity also enables them to extend credit in cases where a large issuer relying solely on credit scores wouldn't.

Marketing costs less too, since community banks target existing customers, rather than blindly mailing out offers across the country, Craft says.

Hammer says it's important for banks entering the card business to go in with realistic expectations. "They think they're going to make money in a year or year and a half, when it might take two or three years," he says.

He adds that the quest for profits could lead some banks to stretch their underwriting rules, so he advises banks to hire a specialist in cards for the underwriting, instead of relying on traditional loan officers. "Credit cards are unlike any other form of lending," he says. "It's unsecured, so the dynamics of the business model are different compared to any of the more traditional forms of lending."

Buhrmaster disputes the idea that small banks need to bring in card specialists to evaluate credits.

Community banks as a whole have seen far fewer delinquencies and chargeoffs than the top credit card issuers, due largely to their more conservative underwriting. First National Bank of Scotia's losses from credit cards are so minimal that the bank doesn't even calculate them regularly, Buhrmaster says.

"If you understand what credits you're underwriting, you're going to be a good underwriter, whether it's a credit card, a mortgage, or a commercial loan," he says.